A stronger U.S. dollar: the winners and losers

Like most changes, the surging value of the dollar is creating both winners and losers. It is a blessing for American consumers and those of us who would like a spring vacation in Europe. On the other hand, in the future, it could be a bane in the lives of Americans looking for jobs in manufacturing because it causes the price of American exports to go up, and imports to become cheaper.

The stronger greenback is a reflection of the strength of the U.S. economic recovery, but maybe even more so the weakness of the economies of the Eurozone and Japan. In a global economy, it is important to focus on broad trade-weighted measures of the exchange rate that reflect the relative importance of America’s trade with other countries.

Thus, the fact that Russia’s ruble has lost half its value against the U.S. dollar means little to America’s economy since trade with Russia is minimal. It’s a different story with the euro and yen, since the U.S. considers Japan and Europe major trading partners. Adjusted for inflation differences, the trade-weighted dollar has risen by 30 % from its low in 2011—about the same increase it saw during the dot com boom of 1995 to 2002, but it remains far below the prior peaks of 1985 and 2002.

The U.S. and China stand out as two countries whose currencies have experienced the largest appreciation. Japan has witnessed the largest depreciation; the value of the yen has dropped about 30% over the past three years, as Prime Minister Shinzo Abe’s government aims to rejuvenate Japan’s economy. The euro has fallen nearly 20% against the dollar over the past year, but its trade-weighted decline is actually half that or less than 10%, as other trading partners have followed its value down.

Exchange rates are largely determined by basic forces of supply and demand, but their changing values are frustratingly hard to predict, and large fortunes have been won and lost in bets in their future values. To the extent that foreign exchange is desired for the purpose of purchasing the goods and services of other countries, exchange rates will reflect the relative strength of countries’ business activity and differences in rates of price inflation, basic determinants of the demand for exports and imports.

With the growing openness of international capital markets, exchange rates have become more reflective of perceived differences in investment opportunities and they are often dominated by developments in financial markets. That change is particularly true in recent years as innovations in monetary policy, such as various versions of large-scale bond purchases known as quantitative easing, reflect a commitment to an accommodative monetary policy stance extending far into the future, which can have strong effects on exchange rates.

Expectations that interest rates will stay low lead to reduced demand for assets denominated in the domestic currency, and as a result, exchange rate depreciation. With the shift away from quantitative easing in the United States, and its expansion in Japan and the Eurozone, the price of the dollar can be expected to rise even further in relative terms.

To date, these large realignments of currency values among the major economies have had surprisingly small effects on trade flows. Substantial increases in the real value of the dollar in the early 1980s and 2000s were both associated with the emergence of large trade deficits, and the subsequent declines moved the trade balance back toward zero. We came to associate a 10% rise in the real exchange rate with a fall in in the trade balance of 1-1½% of GDP.

The lack of change in the U.S. trade balance might be attributed to a lagging response to what has been a fairly recent turnaround — the dollar had been declining in value prior to 2012. And, the U.S. trade deficit will be held down in the short-run by the abrupt drop in the price of imported oil.

The failure of Japan to generate a larger improvements in its trade is more puzzling. More than two years have passed since so-called “Abenomics” initiated a sharp yen depreciation, yet the trade balance shows little evidence of change. Economic developments within the eurozone are also disappointing. The European Union needs a realignment of competition among its members – an effective devaluation in the South and relative price appreciation in the North. Yet, with a common exchange rate, improved competitiveness with the rest of the world brings only ever-growing surpluses for Germany, while the peripheral countries continue to struggle.

Ongoing exchange realignments and shifting trade balances could become more divisive in future months now that the European Central Bank has joined the Bank of Japan in a large program of monetary expansion. As lagged effects of the exchange rate changes work through the trading system, the negative effects on U.S. growth will become pronounced and competitive tensions over exchange rate policies will rise.

Barry Bosworth is a senior fellow in Economic Studies at the Brookings Institution.

The U.S. Dollar Index, which measures the buck against six major western currencies but not against emerging market currencies such as China’s yuan, has risen 7.1% in the third quarter, its biggest quarterly rise since the 2008 market panic . . . the world’s premier reserve currency is also at seven-month highs against Brazil’s real and Mexico’s peso, and near a six-month high against India’s rupee. The only major trading partner it isn’t strengthening against is the yuan, partly because of weaker demand for commodities (which are priced in dollars) from a slowing Chinese industrials sector.

That’s right, despite the manywarnings in recent years that Fed policies are destroying the value of the dollar, the greenback hasn’t been stronger since the financial crisis. As Smith points out, the short-term reasons for the dollar’s surge is clear: the Federal Reserve is winding down its bond buying program while Japan is still pumping reserves into its banking system and Europe is considering a quantitative easing program of its own. But beyond these, there are fundamental economic reasons for the dollar’s rise, as well as reasons to believe that these trends could bode well for the global economy.

So why, beyond stimulus measures, is the dollar gaining value against foreign currencies? The best explanation is the difference in growth rates between the U.S. and the rest of the world. Growth in the 18-member eurozone has basically been stagnant for three years now, with the most recent readings showing that the usual engines of its economy, Germany and France, shrank or stalled in the second quarter of 2014. Japan, meanwhile, has only had one quarter of real GDP growth above 2% in the past five years, which makes the U.S. economy’s latest quarterly growth reading of 4.2% look a lot better.

Standard economic theory says that investors will flock to economies that are growing faster, and to do that, they need to buy the currency of that economy. In today’s world, that means the dollar will be in greater demand because investors will need to buy dollars to invest into the relatively strong American economy.

But what about exports? The logic of the argument that the world is descending into a series of currency wars–whereby central banks around the world are devaluing their currency in order to make their exports cheaper and boost their domestic economies–depends on central banks not letting up on stimulus. But at least in the case of the U.S., it’s clear that the American economy would benefit from allowing QE programs to help boost the sluggish Japanese and European economies to grow, even if it means a stronger dollar. As Neil Dutta, head of Economics for Renaissance Macro Research, wrote in a note to clients this week, “While a rising dollar keeps import price pressures low and hurts export competitiveness, the US is a fairly closed economy. That is, dollar movements have a fairly small impact on import prices and export activity.” He goes on to write, “There is a much more elastic relationship between global growth and exports than the [the relative value of] the dollar.”

In other words, It’s better for U.S. exporters, and the broader U.S. economy, that Japan and the EU are growing quickly than to have a favorable exchange rate situation.

And with the rest of the developed world facing the same hurdles as the U.S. in terms of aging populations, growing inequality, and stagnant wage growth, there’s little reason to believe that the U.S. won’t continue to outpace the rate of growth of the rest of the developed world. With that tailwind at the dollars back, and monetary stimulus just now getting underway in other parts of the world, we could see King Dollar reigning for years to come.

Toyota nearly doubles profits, sells more than 10 million cars

FORTUNE — Buoyed by increasing car sales and the devaluation of the Yen, Toyota Motor TM posted profits of $17.9 billion for its fiscal year 2014, up 88% from $9.5 billion a year earlier. The Japanese automaker’s car sales were up by nearly half a million units for the year, totaling 10.1 million cars sold compared to 9.7 million the previous year.

This included increased sales in all regions except for Asia.

In a press conference yesterday in Toyko, Toyota president Akio Toyoda focused on controlled growth, rather than trying to move too quickly. “I believe that sustainable growth means growing steadily each year under any circumstances,” he said. Toyoda acknowledged that his company was unprepared for the increase in vehicle sales and had trouble keeping up. “Our employees and partners were overstretched,” he said.

Toyoda compared the company to a tree that grew too rapidly, that as a result was not able to form a strong enough trunk to protect it from the elements.”

It will be hard sustain the massive growth in the coming year, said Stephen Brown, managing director at Fitch Ratings, because the Yen’s devaluation was a one-time occurrence and because of increasing corporate taxes in Japan. “They’ve got some headwind pressures going forward now,” he said, as opposed to the help the company got last year from the currency devaluation.

The decline in Asian sales could be due to an increasingly difficult market in Thailand. Brown noted that the political turmoil in that country has created problems across the industry.

A factor that could lift sales, especially in North America, is the planned redesign of the Camry, typically a big seller. The previous iteration of the sedan was generally viewed as “conservative,” especially when compared to cars like the Hyundai Sonata and the Ford Fusion, Brown said. “The high level reviews have been fairly positive,” he said. “That should boost their sales here.”